Government Budget Cuts Pose Threat to Recovery

WASHINGTON (AP) — Deep spending cuts by state and local governments pose a growing threat to the fragile economic recovery that is already grappling with high unemployment, depressed home prices and the surging cost of oil.

Lawmakers at state capitols and city halls are slashing jobs and programs, arguing that some pain now is better than a lot more later. But the cuts are coming at a price — weaker growth at the national level.

The clearest sign to date was a report Friday on U.S. gross domestic product for the final three months of 2010. The government lowered its growth estimate, pointing to larger-than-expected cuts by state and local governments. The report suggested that worsening state budget problems could hold back the recovery by putting more people out of work and reducing consumer spending.

Across the country, governors and lawmakers are proposing broad cutbacks — lowering fees paid to nursing homes in Florida, reducing health insurance subsidies for lower-income Pennsylvanians, closing prisons in New York state and scaling back programs for elderly and disabled Californians.

"The massive financial problems at the state and local levels have and will continue to restrain growth," said economist Joel Naroff of Naroff Economic Advisors.

State and local governments account for 91 percent of all government spending on primary education, according to the Brookings Institution. And they provide 71 percent of higher-education spending. States also account for more than 70 percent of spending on roads, bridges and other infrastructure.

But those same governments cut spending at a 2.4 percent rate at the end of last year. And economists predict they will slash their budgets by up to 2.5 percent this year — potentially the sharpest reduction since 1943. The deepest cuts are expected to occur in the first six months of this year.

The worst cuts so far— 3.8 percent — came in the January-to-March period of 2010. That was the sharpest quarterly drop since late 1983, when the U.S. economy was recovering from a severe recession. Most economists think the cutbacks this year will exert an even bigger economic drag than last year.

Newly elected Republican governors are leading the charge. They're acting on campaign pledges to shrink government to meet budget gaps. They favor smaller governments with lower taxes and less regulation, which they say will boost private-sector growth and job creation.

Some Democrats — including Govs. Andrew Cuomo of New York and Jerry Brown of California — have followed suit. They're pushing for cuts to social programs and concessions from unions.

No state has attracted more attention than Wisconsin. Pointing to the state's projected $3.6 billion gap, Republican Gov. Scott Walker wants to strip state workers of collective bargaining rights. He also wants them to contribute more to their pensions and health insurance costs.

The budget fight has taken center stage in Congress. Democrats are bending to Republican demands for spending cuts to avoid a shutdown of the federal government next week.

The reduction in federal spending has a direct effect on states and municipalities. They depend on money from Washington to keep schools operating, put police officers on the street and subsidize public services like job training. The end of federal stimulus programs is also widening state deficits.

Many governors, including those in Florida, New York and Colorado, are pursuing tighter budgets. Their proposals include laying off public workers and teachers, reducing spending for education and health care, and ending some social services. They're also targeting public pension funds and health insurance plans and seeking larger contributions from public employees.

State and local budget experts fear the cutbacks will intensify this year. States are struggling to close budget gaps of about $125 billion for the upcoming budget year, according to the Center on Budget and Policy Priorities.

That's a smaller gap than states faced in the past two years. But this time, governors won't have federal stimulus funds to help close the deficits. And state governments, in turn, are reducing the aid they send to local governments.

"We suspect that these cutbacks are going to deepen over the next couple of quarters," said Mark Muro, a senior fellow at the Brookings Institution. "It's likely we're only beginning to see the state and local drag."

In Florida, newly elected Republican Gov. Rick Scott wants to reduce the state's budget 5 percent. To get there, he wants to slash 8,600 state jobs and reduce Medicaid costs through a 5 percent cut in fees paid to hospitals and nursing homes, but not doctors.

Health-insurance cuts are popular with many Republican governors. Pennsylvania Gov. Tom Corbett, facing a projected $4 billion-plus deficit, said he can't find the cash to extend a program that subsidizes health care for 41,000 lower-income adults and is nearly out of money.

Arizona Gov. Jan Brewer is suggesting that the state drop Medicaid coverage for 250,000 low-income people to make up about half of the state's projected shortfall of about $1 billion.

It's not just Republicans demanding tough fiscal medicine. In New York, Gov. Cuomo has said up to 9,800 state employees could be laid off if public-employee unions don't agree to millions of dollars in concessions.

The newly elected Democrat has also proposed $1 billion in cuts to New York's Medicaid program, with its 4.7 million recipients. He also wants to close some prisons, freeze wages for nearly 200,000 state workers, cut $1.5 billion in aid to public schools and chop 10 percent from the state's operating budget.

In California, Brown has imposed a state hiring freeze and is proposing cuts to a host of social programs that serve the poor, elderly and disabled. He is also seeking more than $12 billion in tax extensions and fees. The state is grappling with a $26.6 billion fiscal crisis.

State spending represents just a fraction of the nation's economic activity. Consumers typically spend roughly six times more than state and local governments do. So a big increase in consumer spending can offset public-sector cuts.

U.S. consumers boosted spending at a 4.1 percent annual rate in the final quarter of 2010 year; state and local governments cut spending at a 2.4 percent pace. If consumers had spent just 0.4 percentage point more, they would have offset the state and local government cutbacks.

That said, layoffs hurt consumer spending. And states and local governments are cutting their payrolls. State and local governments have cut more than 400,000 jobs in the past two years. Budget pressures will force an average of 20,000 more job cuts each month for the rest of this year, estimates Jon Shure of the Center on Budget and Policy Priorities, a left-leaning think tank.

State tax revenue has begun to grow again after falling sharply in recent years. But many governors are now proposing tax cuts as a way to encourage business activity, Shure said. That's likely to escalate pressure for spending cuts because most states must balance their budgets each year.